Opt-out options in new product co-development partnerships

Savva, N and Scholtes, S (2014) Opt-out options in new product co-development partnerships. Production and Operations Management, 23 (8). pp. 1370-1386. ISSN 1059-1478

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Abstract

We study three contractual arrangements -- co-development, licensing, and co-development with opt-out options -- for the joint development of new products between a small and financially constrained innovator firm and a large technology company, as in the case of a biotech innovator and a major pharma company. We formulate our arguments in the context of a two-stage model, characterized by technical risk and stochastically changing cost and revenue projections. The model captures the main disadvantages of traditional co-development and licensing arrangements: in co-development the small firm runs a risk of running out of capital as future costs rise, while licensing for milestone and royalty (M&R) payments, which eliminates the latter risk, introduces inefficiency, as profitable projects might be abandoned. Counter to intuition we show that the biotech's payoff in a licensing contract is not monotonically increasing in the M&R terms. We also show that an option clause in a co-development contract that gives the small firm the right but not the obligation to opt out of co-development and into a pre-agreed licensing arrangement avoids the problems associated with fully committed co-development or licensing: the probability that the small firm will run out of capital is greatly reduced or completely eliminated and profitable projects are never abandoned.

Item Type: Article
Additional Information: © 2014 John Wiley & Sons, Inc.
Subject Areas: Management Science and Operations
DOI: 10.1111/poms.12059
Date Deposited: 02 Mar 2016 18:51
Last Modified: 17 May 2016 11:17
URI: http://lbsresearch.london.edu/id/eprint/157

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